In my last post, I made the argument that the new Fed rules against banks are the right rules at the wrong time, and in the wrong way. Not being a student of banking history, I was reminded that liquidity rules were done before, with disastrous results.
In 1936 the Fed moved banks toward a liquidity requirement as a response to the Great Depression. This resulted in a recession while still recovering from the Great Depression.
Then the run up to World War II happened, and banks were allowed to capitalize on the Government’s dime in order to spur production (and full employment) for the war effort. In the post war years, banks were allowed to keep their capitalization and leverage ratios, instead of going back to liquidity.
The new rules kinda make sense in the backdrop of Ben Bernanke being one of the most accomplished scholars on the Great Depression. So maybe he’s theorizing something different from the 1936 model that didn’t work out so well.
That being said, and Bernanke being given his “propers”, liquidity has to be followed with a flow of money into the general economy; something that banks have been unwilling to do since 2008. At what point does the dam burst? My back-of-the-napkin guess is $3 Trillion in liquidity. The Fed is only at $1.4 Trillion in QE. So if Bernanke goes forward with the new rules, he’s going to have to pour on the liquid – and fairly quickly.